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The world’s biggest Muslim country wants to boost sharia finance

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THE Indonesia Stock Exchange greeted its latest listing on May 9th: that of BRIsyariah, the Islamic arm of state-controlled Bank Rakyat Indonesia, the country’s biggest bank by assets. The initial public offering (IPO) of 27% of BRIsyariah’s equity raised around 1.3trn rupiah ($92m). Islam outlaws the payment of interest, the basis of conventional banking. Yet despite being home to an eighth of the world’s Muslims—225m, in a population of 260m—Indonesia’s Islamic banks are tiny. They account for just 5.8% of all banks’ assets. In neighbouring Malaysia, which has been promoting Islamic finance for many years, Islamic banks’ share exceeds 25%.

But Indonesia’s are growing fast. According to the Financial Services Authority (OJK), the industry’s supervisor, last year their assets rose by 19%, against 9.8% for conventional banks. BRIsyariah’s IPO will help tackle what the OJK says is the biggest obstacle to their development: a want of capital. Indonesian regulation divides banks into four categories; the more tier-1 capital they have, the broader their range of permitted activities. Of the 13 Islamic banks run as separate entities from their conventional parents, none is in category 4—banks with capital above 30trn rupiah, which are permitted to operate globally. BRIsyariah expects to become only the second in category 3 (over 5trn rupiah and allowed to operate in Asia). Lack of capital, says the OJK, means fewer branches and dearer funding, which constrains Islamic banks to focus on retail rather than corporate customers.

To appeal, Islamic products must be competitive with conventional ones, says Mohamed Damak of S&P Global, a rating agency. But sharia banking is far from doomed to failure. Arsalaan Ahmed, the chief executive of the Malaysian subsidiary of HSBC Amanah, the bank’s Islamic division, says that 65-70% of his retail customers are not Muslim.

Last year Indonesia’s president, Joko Widodo, known as Jokowi, set up a committee to promote Islamic finance and establish Indonesia as a hub. In June the OJK published a two-year “roadmap”. The supervisory body is also promoting awareness of sharia products: a survey in 2016 found that only 6.6% of Indonesians understood them. A council of Islamic scholars established several years ago may help avoid disputes over whether products meet sharia standards. Whether it will be as successful as Malaysia’s, which is housed in the central bank and enjoys legal authority, is not yet clear.

Lack of scale, says Herwin Bustaman, head of sharia banking at the Indonesian arm of Maybank, Malaysia’s biggest lender, bedevils all small banks, not just Islamic ones. But some banks’ legal structures make matters worse. A bank may create either a separate entity for its sharia division (eg, BRIsyariah) or a “sharia business unit” (UUS) that uses the capital, branch networks and personnel of the parent (eg, Maybank). The latter, says Mr Bustaman, is much cheaper: he says he matches the returns and cost-income ratios of conventional banks. The UUSs’ non-performing loans are just 2.5% of the total, against 4.6% at stand-alone entities. Their return on assets averages 2.4%, versus 1.2%.

It would be hugely helpful, says Mr Bustaman, if the OJK embraced the UUS model. A law from 2008, however, points the other way. A UUS must be spun off once its assets are half those of its parent (only a handful, including Maybank’s, reach even 10%) or in any event by 2023. The OJK is preparing simpler regulation allowing subsidiaries to use their parents’ branches, computers and people. Letting UUSs continue might be simpler still.

Regardless of legal form, the fastest route to scale may lie in Jokowi’s ambitious infrastructure plans and in loans to big companies. Even handling a tenth of the many billions being splurged on roads, railways and so forth would double Islamic banks’ assets, Mr Bustaman reckons. Indonesia is already the top international issuer of sovereign sukuk (sharia-compliant bonds), points out Bashar Al-Natoor of Fitch, another rating agency, and this year sold the first “green” sukuk, raising $1.25bn, although Malaysia issues far more sukuk in all through its domestic market.

The OJK says it indeed expects Islamic banks to play a bigger role in infrastructure. It also envisages a special role for them in financial inclusion, microfinance and supporting small businesses—which, it says, will differentiate Indonesia’s model from those of Malaysia and the Gulf states. Yet financial inclusion is rising fast anyway. The share of Indonesians aged 15 and over with bank accounts leapt from 36% in 2014 to 49% last year, according to the World Bank. Conventional banks and Asia’s technology companies will also vie to serve them. Islamic banks have their work cut out.

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Japan still has great influence on global financial markets

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IT IS the summer of 1979 and Harry “Rabbit” Angstrom, the everyman-hero of John Updike’s series of novels, is running a car showroom in Brewer, Pennsylvania. There is a pervasive mood of decline. Local textile mills have closed. Gas prices are soaring. No one wants the traded-in, Detroit-made cars clogging the lot. Yet Rabbit is serene. His is a Toyota franchise. So his cars have the best mileage and lowest servicing costs. When you buy one, he tells his customers, you are turning your dollars into yen.

“Rabbit is Rich” evokes the time when America was first unnerved by the rise of a rival economic power. Japan had taken leadership from America in a succession of industries, including textiles, consumer electronics and steel. It was threatening to topple the car industry, too. Today Japan’s economic position is much reduced. It has lost its place as the world’s second-largest economy (and primary target of American trade hawks) to China. Yet in one regard, its sway still holds.

This week the board of the Bank of Japan (BoJ) voted to leave its monetary policy broadly unchanged. But leading up to its policy meeting, rumours that it might make a substantial change caused a few jitters in global bond markets. The anxiety was justified. A sudden change of tack by the BoJ would be felt far beyond Japan’s shores.

One reason is that Japan’s influence on global asset markets has kept growing as decades of the country’s surplus savings have piled up. Japan’s net foreign assets—what its residents own abroad minus what they owe to foreigners—have risen to around $3trn, or 60% of the country’s annual GDP (see top chart).

But it is also a consequence of very loose monetary policy. The BoJ has deployed an arsenal of special measures to battle Japan’s persistently low inflation. Its benchmark interest rate is negative (-0.1%). It is committed to purchasing ¥80trn ($715bn) of government bonds each year with the aim of keeping Japan’s ten-year bond yield around zero. And it is buying baskets of Japan’s leading stocks to the tune of ¥6trn a year.

Tokyo storm warning

These measures, once unorthodox but now familiar, have pushed Japan’s banks, insurance firms and ordinary savers into buying foreign stocks and bonds that offer better returns than they can get at home. Indeed, Japanese investors have loaded up on short-term foreign debt to enable them to buy even more. Holdings of foreign assets in Japan rose from 111% of GDP in 2010 to 185% in 2017 (see bottom chart). The impact of capital outflows is evident in currency markets. The yen is cheap. On The Economist’s Big Mac index, a gauge based on burger prices, it is the most undervalued of any major currency.

Investors from Japan have also kept a lid on bond yields in the rich world. They own almost a tenth of the sovereign bonds issued by France, for instance, and more than 15% of those issued by Australia and Sweden, according to analysts at J.P. Morgan. Japanese insurance companies own lots of corporate bonds in America, although this year the rising cost of hedging dollars has caused a switch into European corporate bonds. The value of Japan’s holdings of foreign equities has tripled since 2012. They now make up almost a fifth of its overseas assets.

What happens in Japan thus matters a great deal to an array of global asset prices. A meaningful shift in monetary policy would probably have a dramatic effect. It is not natural for Japan to be the cheapest place to buy a Big Mac, a latté or an iPad, says Kit Juckes of Société Générale. The yen would surge. A retreat from special measures by the BoJ would be a signal that the era of quantitative easing was truly ending. Broader market turbulence would be likely. Yet a corollary is that as long as the BoJ maintains its current policies—and it seems minded to do so for a while—it will continue to be a prop to global asset prices.

Rabbit’s sales patter seemed to have a similar foundation. Anyone sceptical of his mileage figures would be referred to the April issue of Consumer Reports. Yet one part of his spiel proved suspect. The dollar, which he thought was decaying in 1979, was actually about to revive. This recovery owed a lot to a big increase in interest rates by the Federal Reserve. It was also, in part, made in Japan. In 1980 Japan liberalised its capital account. Its investors began selling yen to buy dollars. The shopping spree for foreign assets that started then has yet to cease.

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